Financial Mis-selling - Real World Cases Of Mis-selling - Assessment Answer

Financial Mis-selling Assignment

Assignment Task

Within your assignment you are required to one, consider the causes of mis-selling and two, relate these causes to some really world mis-selling cases:

How and why does financial mis-selling occur?

Critically discuss the question making reference to different perspectives and theories.

Outline and describe two real world cases of mis-selling [as provided on the module blackboard site or from your own research] and indicate how and why financial mis-selling has developed in these cases.

Introduction:

Financial services are inherent for the sustainability of the modern life for both households and firms. In this context, banks play a vital role in providing financial services to both the consumers and firms. Banks make it sure that the financial services provided by them are used for productive uses. Banks also make it sure that customers both firms and households are purchasing less risky financial services than the risky financial instruments available in the open market. However, many financial institutions in order to increase their sales of financial services use ignorant, aggressive or even incompetent sales tactics which are opposite to ethical financial selling. However, according to Carlin and Manso (2010), when banks or financial institutions are unable to advice consumers regarding the use of financial services, it also results in financial misselling.

The current assignment therefore, focuses on understanding the reason and the ways by which financial misspelling occurs. The assignment also takes into account different real world cases of financial misspelling that has shown the true picture of some of well known financial institutions in the globe.

i) How and why does financial mis-selling occur?

There are different reasons why financial misspelling occurs. According to Ericson and Doyle (2006), banks and other financial institutions use deliberate strategies in order to sell financial services to consumers to consumers which are not required in the day to day activity of consumers. This type of activities is considered as financial misspelling. According to Ferran (2012), selling financial services to consume which are inappropriate questions the business model of banks whereas it also raises questions to the ethical behaviour of banks towards consumers. The result of such misspelling is disastrous to banks as consumers distrust the firms that misled them. On the other hand, reputation of banks also decline due to the misspelling practice undertake by banks and other financial institutions.

Georgosouli (2011) identified that misselling cause due to the intense activities undertaken by sales persons in making the consumers understand that the financial services are essential for them even though it is not necessary to have the financial service. On the other hand, researchers like Hill and Kosup (2007), found out that misselling causes due to the inability of consumers in making their decisions regarding financial services. Customers are unaware regarding what they are buying and why they are buying. However, Inderst and Ottaviani (2009) argued that banks and financial institutions have brought into such financial practices that lead individuals to deceive people for buying non-required financial services. It therefore, causes huge financial distress among consumers and as a result causes economic destabilising likewise the great financial crisis of 2008-09 in USA.

Stango and Zinman (2009) remarked that financial misselling is mostly seen in cases of pensions and insurance services. Sales persons usually mislead consumers regarding payment protection services and pension schemes. This has resulted in the increased number of complaints from consumers. More than 60% of consumers who have invested in payment protection insurance have stopped their investment after few years due to deceiving advice. Apart from these two practices, advising consumers to have expensive and at the same time unsuitable mortgage loans is a result of poor practice in financial selling services.

Stegman (2007) pointed out that the modern world is a financialised world where the role of the state is declining in order to provide financial protection to their citizens. Even after earning more than previous generations, people in the modern age urge for more. Huberman and Jiang (2006) found out that people in the modern financialised era are recognised by their spending pattern. In other words, in order to recognise themselves within the society, consumers are pressurised to consume more which provides an opportunity to the financial service providers to mislead them regarding different products. Schwartz et al. (2011) agreed with this factor and added that development of new products and services and new marketing tactics also work as an instrument to mislead consumers regarding different financial services.

Carlin (2009) termed globalisation of economy as a major factor in driving misselling of financial services. It has increased borrowing and lending powers of consumers around the globe. Within the 27 members states of European Union, more than 1 trillion Euro was borrowed in 2007 which is equal to double compared to the previous years. It is due to the financial practices undertaken by banks. Due to over indebtness, more than 35% of EU households were unable to pay their debt as well as other debts. Thus, the continually misleading practices in the financialised world have become the main reason of miselling as it provides enough opportunity for financial institutions to deceive the consumers.

Inderst and Ottaviani (2009) is of the point of view that financialised world cannot be the only reason for misselling activities undertaken by financial institutions as predatory and abusive lending is another major reason that drive such practices. In UK, the abusive lending practices are at its highest stage. Consumers are given loans without acknowledging their income or the ability to repay it. Even though, they do not required that services, they are forced or manipulated to take the services for high interest rates. The firs also become unable to provide an accurate agreement of the long term loans. It works as an instrument of financial misselling to consumers leading to huge consumer complaints as well as financial disestablishment. As far as predatory lending is concerned, McGovern and Moon (2007) found out that banks use high fees, interest rates and deceive and aggressive marketing tactics for increasing their profit which acts as misselling activity. However, according to Perry and Motley (2009), selling of bonds which actually incur interest rates and a capital at the same is another form of misselling of financial services. Even though it intends to provide benefits to consumers after few years in most of the cases, it is deceiving. The case of Goldman Sachs is a good example to show this misselling practice where the bank was sued by USA federal court for selling highly suspicious and complex mortgage backed securities. However, many scholars and researchers argue that apart from organisational level, the baises in decision making, especially those that are driven by emotion helps banks to missell their products. As consumers are the ultimate decision makers regarding the acceptance of any services, their decision making instrument that is the human brain can be regarded as a major factor in increasing the number of misselling cases in the current business scenario.

Different reasons have been outlined for misselling. However, it is also important to understand the way by which consumers are missold financial services. Carlin and Manso (2010) found that conflict of interest between individuals, organisations and personal and impersonal level help in misselling whereas Ericson and Doyle (2006) is of the view that banks manipulate consumers by providing them with huge number of choices as well as pricing of services. Ferran (2012) found out that as financial services are too complex to understand by average consumers, firms are easily able to manipulate them to take the services. In this context, Georgosouli (2011) pointed out that the way advertisers show benefits in having new financial services to consumers, they can be blamed for misleading. As consumers are provided with a large number of choices, they are unable to identify which products to choose whereas the manipulation from the sales persons leads to poor financial service selection. In many cases, it is seen that consumers are not provided with accurate information regarding actual money invested after all taxes and commissions. It is the matter of organisational interest whereas sales persons for their own interest try to deceive consumers.

Hill and Kosup (2007) found out the concept of loyalty and customer preference where brand matters the most. It is found out that more than 80% of UK consumers do not want to leave a bank or financial service provider for another financial service provider that they do not know. In UK, the shifting patter of consumers’ accounts to only 3.2% in 2010 compared to 6% in 2005.

The Klemperer Switching model shows that a financial institution after introducing new products attracts new consumers. Over a period of time, the number of existing customers and new customers increase whereas when it is able to attract consumers and gain their trust, existing customer constitutes more than 90% of consumers for a bank. Taking the advantage of this consumer preference, loyalty and brand selection behaviour, banks are able to initiate misselling in order to increase their profit. As consumers have their faith and trust in them, they become easy victims of misselling (Hse.gov.uk, 2016).

As shown in the above discussion, there are different causes of financial misselling. Due to the increasing number of financial misselling cases, new rules have come, especially after 2008-2009 financial crises where banks are punished for their inappropriate practices. In UK, the fines for financial misselling have risen to £2,471,966,519 as regulatory framework has

improved to protect consumers to be misled by banks or the respective sales persons of banks. During the period of 2002-2015, more than 516 fines for such financial misselling has been recorded (Nera.com, 2016). It shows that even after intensive practice made by government to restrict financial misselling, it is increasing day by day and therefore, different measures needs to be taken.

ii) Outline and describe two real world cases of mis-selling [as provided on the module blackboard site or from your own research] and indicate how and why financial mis-selling has developed in these cases.

The Case of HSBC:

HSBC is among the best retail banking service providers of UK. However, there are proved allegations over the company for misselling financial products. The allegation is that HSBC is misselling to elderly people of UK who intends to pay for their care homes. It is found that the subsidiary of HSBC, NHFA has sold products in a wrong way to its customers. The advisers of this bank has advised consumers, mostly of them are more than 83 years of age in a deceiveable way. The advisers asked the vulnerable patients to invest in a five year plan. NHFA was among the trustable financial service providers in UK among elderly and vulnerable people. The intended consumers believed that NHFA would make a good use of their investment for their health and social care costs. However, the decision was entirely a wrong one and therefore, it has declined the trust of consumers from financial service providers.

It is found by the FSA that 2485 customers were advised for the unsuitable investment in a five year investment period whereas more than 87% of the advised consumers have already invested in the products advised. The total money for this investment amounted to £115,000. NHFA has used 15-31 advisers in structuring care cost whereas during this period, a total of 11000 consumers were taken into consideration for the financial advice. HSBC has focused on reviewing the advice as well as on compensating the consumers who has invested. However, the FSA, the regulatory framework board of UK has fined this bank £10.5 million as well as another £29.3 million as a part of compensation for the affected consumers (Livemint.com, 2016).

The main reason why this case is considered as a misselling activity is due to the fact that life expectancy of the targeted consumer groups was less than the actual 5 years investment period advised. The average age of the consumers was 83 and therefore, they might or might not leave for five years. In this context, this unethical behaviour is an offence and at the same time a moral risk, especially as this case is related to elder and vulnerable people. Inderst and Ottaviani (2012) found out that moral risk rises in misselling cases whenever it is connected with elderly people and so as the current case is. Another reason why the current case is elevated to a misselling case is due to the fact that the targeted consumers were not comprehensive enough to make their own decision regarding the financial services. They are ignorant about the benefits and complexity of financial services. This is applied to the current case as the people who are over 83 years do not have the consciousness to make decisions regarding which one is good for them. In this situation, like a good shopkeeper, HSBC might have advised the consumers regarding merits and demerits of purchasing the product. However, the advisers have not followed that as they made the deal beneficiary for the consumers in order to pay their care home cost. This case is therefore, is an attempt of unethical behaviour as well as attempt abusive transactions. Further, limited financial literacy of consumers become an important reason why the firm has initiated a misselling practice as seen from the current case.

The way misselling occurred for the current case can be discussed from both firm level and consumer level. From the firm level, due to own conflict of interest, the consumers have taken the decision of investing into the five year plan even after knowing that they might leave or might not in the next five years. On the other hand, the organisation has taken the help of deceive practice in order to increase their sales performance. As per consumer level practice, the subsidiary of HSBC was considered as trustworthy by the elderly and distrusted others for their financial services. Taking the advantage of low shifting pattern and consumer loyalty attitudes, the company has mislead the consumers and therefore, the current case is a misselling one.

The case of Alliance & Leicester:

Alliance & Leicester is fined more than £7 million for misselling. Within a span of two years from 2005 to 2007, the company sold 210,000 PPI bonds to customers. The main reason was to seek for loans at the price of £1,265. However, in this case, the telephonic staffs of the company were unable to make the consumers understand the actual cost of the payment protection insurance. It is alleged that the staffs were trained to pressurise the consumers to take the PPI whereas the telephone staffs did the same to make the consumers understand about the usefulness of taking the services. However, many of the consumers become suspicious regarding the inclusion of PPI in their quotation of a loan. This situation continues for more than 3 years and therefore, resulted in unethical practice by the financial service providers. The main factor outlined in this case is the inability of the firm in making the consumers understands about the terms and conditions of PPI in their quotation. A&L has provided the information that it will conduct an overview programme where each & every customer will be contacted who has taken the PPI through telephone between 14 January 2005 and 31 December 2007 (Telegraph.co.uk, 2016). This case is an example which shows that FSA would take action against any company that missell its products to consumers.

It is found that financial misselling occurs when consumers are deceived with products that will not give them the profit that they are searching for. Further, it is also found that misselling occurs when consumers are forced to take a financial product or service that they do not require. In the current case, it is seen that with a loan service, consumer are forced to take another financial service namely PPI with their quotation. The main reason why this case is considered as misselling as the staffs of the company were unable to make the consumers understand regarding the cost of PPI as well as the true nature of PPI which is an non-ethical dilemma. The payment protection insurance was an optional one which the customers need not to buy. However, the staffs at A&L did not make it clear to firms and therefore, it has become an act of crime. As per the Kant’s Honest Shopkeeper model, an honest shopkeeper would return correct amount of money to all its customers even though they are unable at counting the money. However, when the shopkeeper does the opposite, it is unethical and a moral risk (Schwartz et al. 2011). The current case shows that A&L does not consider the fact of honest shopkeeper and went on to sell an optional product as an essential one. The main cause therefore, being the organisational interest in achieving higher sales margin and higher organisational profit. Further, from the analysis, it is also identified that the firm did not follow a sustainable business model due to which consumers might lost their trust over the organisation. The result being the loss of reputation of the bank as a financial service provider which might hit the firm in the long run in attracting consumers and gaining their trust.

The company has taken the advantage of low shifting patterns of consumers from one bank to another for financial services. Further, it has taken the advantage of consumer trust being their best financial service provider. It is found that consumers prefer to get financial services from only one organisation rather than others. In this case, A&L has taken this as an advantage for deceiving the people with payment protection insurance.

Conclusion:

From the above analysis, it is found out that there are different reasons why financial misselling occurs. The analysis has made it clear that in real world cases as well financial misselling is inherent as consumers are being deceived by financial institutions by taking the advantage of their ignorance regarding financial services. The two cases analysed shows that illiteracy and complexity regarding the knowledge of financial services leads the consumers to be deceived. On the other hand, it is also found out that in organisational conflict of interest and individual decision making process are the two main factors that drive financial misselling. Banks take the advantage of trust of consumers and undertake unethical behaviour for increasing their performance. Even after strict regulations, it is increasing in huge number and therefore, there are requirements for the consumers to be aware regarding what is good for them and what is not. Merely swaying by emotion will result in repeated misselling to them.